Summary
finding that Massachusetts homestead exemption statute did not allow for the exemption of cash proceeds
Summary of this case from In re WalleyOpinion
Case No. 99-11836-JNF.
June 27, 2007
MEMORANDUM
I. INTRODUCTION
Two matters are before the Court: the Chapter 13 Trustee's Objection to the Debtor's Claim of Exemption, and the "Motion of William H. Thurston to Authorize (1) Reimbursement of Out of Pocket Costs Incurred by Debtor in State Court Litigation and (2) Payoff of SBA Disaster Loan from Settlement Proceeds." Specifically, through an amended Schedule C-Property Claimed as Exempt, the William H. Thurston (the "Debtor") seeks to exempt, pursuant to Mass. Gen. Laws ch. 188, § 1 or Mass. Gen. Laws ch. 234 [sic], one hundred percent of his "interest in net Proceeds of State Court litigation to repair/restore homestead and repair/replace personal property including destroyed household goods and furnishings following extensive flooding damage." The Chapter 13 Trustee objects to the Debtor's amended exemption claim, asserting that the Massachusetts homestead does not apply to cash proceeds received by the Debtor in settlement of a lawsuit, adding that the Debtor failed to adequately disclose his prepetition damage claim and failed to disclose the commencement of a lawsuit to recover those damages during the pendency of his Chapter 13 case. The determinative issues are whether the settlement proceeds are exempt property, and whether the Debtor may use the proceeds to satisfy a Court-authorized, postpetition secured loan for which his non-debtor spouse is also liable, as well as other costs associated with the litigation.
The Court heard the Chapter 13 Trustee's Objection on April 5, 2007, together with the "Motion of William H. Thurston and Kathleen Thurston to Allow Administrative Claim pursuant to 11 U.S.C. § 503(b)." The Debtor subsequently withdrew that Motion and filed, in its stead, the Motion to Authorize (1) Reimbursement of Out of Pocket Costs Incurred by Debtor in State Court Litigation and (2) Payoff of SBA Disaster Loan from Settlement Proceeds. The Chapter 13 Trustee objected to the newly filed Motion.
The material facts necessary to decide the matters before the Court are not in dispute, except that the figures utilized by the parties in describing the settlement proceeds and costs are irreconcilable and will require an accounting. Neither the Debtor nor the Chapter 13 Trustee requested an evidentiary hearing. Accordingly, the Court now makes the following findings of fact and rulings of law in accordance with Fed.R.Bankr.P. 7052.
II. FACTUAL BACKGROUND
The Debtor filed a voluntary Chapter 13 petition on March 8, 1999. In his Schedules, the Debtor listed the value of his residence, located at 19 Liberty Street, Middleton, Massachusetts, at $145,000, subject to recorded liens in the sum of $59,508, leaving equity in the sum of $85,492. The Debtor claimed the Massachusetts homestead exemption in the specific amount of $96,096. He did not list any contingent claims or causes of action as assets on Schedule B-Personal Property, although in his Statement of Financial Affairs, he disclosed "[f]looding damage at debtor's residence," adding "Debtor has pending claim asserting claim against abutter. Debtor has no flood insurance applicable to this claim."
The Court is unable to determine why the Debtor chose that figure. The homestead exemption available to him under Massachusetts law in effect in 1999 was $100,000, and his equity in the property was $85,492.
Approximately ten months after filing his Chapter 13 petition, on February 24, 2000, the Court confirmed the Debtor's Chapter 13 plan. Through his plan, the Debtor proposed to make monthly payments of $331 for 60 months and provide a 10% dividend to unsecured creditors whose claims totaled approximately $179,000.
In addition to failing to list his unliquidated, contingent claim against an abutter on Schedule B-Personal Property, he did not list the claim in his Liquidation Analysis attached to his Chapter 13 plan. The order of confirmation provided:
Unless otherwise ordered by the court, all property of the estate as defined in 11 U.S.C. § 541 and 1306, including, but not limited to, any appreciation in value of real property owned by the debtor as of the commencement of the case shall remain property of the estate during the term of the plan and shall vest in the debtor(s) only upon discharge. All property of the estate shall remain within the exclusive jurisdiction of the bankruptcy court.
On May 15, 2002, the Debtor filed a "Motion to Authorize Secured Extension of Credit (Home Disaster Loan)," pursuant to which he sought authority to borrow $22,500 from the United States Small Business Administration "in order to make repairs necessitated by recent flooding and for flooding mitigation at debtor's residence. . . . " The Debtor stated that the repairs were necessary "to preserve and protect property of the estate by preventing further flood damage to debtor's residence ar.d further, that debtor's residence is necessary to his reorganization." He added that the current fair market value of his residence was approximately $150,000, which was the current assessed valuation by the Town of Middleton and reflected "a diminution in value to the residence due to property damage from past incidents of flooding." The Debtor disclosed that the term of the loan was ten years, the annual interest rate was 3.5%, and the monthly payment was $230. The "Loan Authorization and Agreement" attached to the Debtor's Motion, which is dated November 27, 2001, reflected that the Debtor and his spouse, who also executed the loan document, agreed to the following:
The Debtor agreed that he would use the loan proceeds to repair property damaged or destroyed in month of March 2001 as follows:
A. Approximately $9,311.00 to repair/replace disaster damaged real estate located at 19 Liberty Street, Middleton, Massachusetts 01949-1806.
B. Approximately $1,600.00 to repair/replace disaster damaged landscaping.
C. Approximately $500.00 for disaster clean-up and debris removal expenses incurred. . . .
D. Approximately $10,400.00 to repair/replace other disaster damaged land improvements, including patio stone, retainer wall and drainage repair, septic pump check and engineering study.
E. $89.00 to repay the Individual and Family Grant Program at IFGP, Dept's of Quality Control. . . .
A. Eligibility for this disaster Loan is limited to disaster losses that are not compensated by other sources. . . . Other sources include but are not limited to . . . claims for civil liability against other individuals, organizations or governmental entities. . . .
B. Borrower will promptly notify SBA of the existence and status of any claim or application for such other compensation, and of the receipt of any such compensation, and Borrower will promptly submit the proceeds of same (not exceeding the outstanding balance of this Loan) to SBA.
C. Borrower hereby assigns to SBA the proceeds of any such compensation for other sources and authorizes the payor of same to deliver said proceeds to SBA at such time and place as SBA shall designate.
D. SBA will in its sole discretion determine whether any such compensation from other sources is a duplication of benefits. SBA will use the proceeds of any such duplication to reduce the outstanding balance of this Loan, and Borrower agrees that such proceeds will not be applied in lieu of scheduled payments.
The Court granted the Debtor's motion, without opposition, on May 23, 2002.
Notably, the Debtor filed a Motion to Amend Schedules the day after he filed the Motion to Authorize Secured Extension of Credit. He filed amended Schedules I and J but did not amend Schedule B to describe his postpetition claims arising in March of 2001.
The Debtor made all required payments pursuant to his Chapter 13 plan. On September 30, 2002, the Chapter 13 Trustee filed her Final Report and Account and Request for Debtor's Discharge. On October 7, 2002, the Court granted the Debtor a discharge, and about two months later, the Court discharged the Chapter 13 Trustee and closed the Debtor's Chapter 13 case.
On February 9, 2005, the Chapter 13 Trustee filed a "Motion to Revoke Discharge Pursuant to 11 U.S.C. § 1328(e) and to Reopen Chapter 13 Case." In her Motion, the Trustee represented that she had learned that the Debtor had filed a complaint in the Essex Superior Court, Department of the Trial Court, in June of 2001, through which he sought damages in excess of $500,000. The Debtor responded to the Trustee's Motion, vigorously challenging any assertion that he procured his discharge by concealing his causes of action. He asserted that he and his spouse had commenced the Essex Superior Court action to recover damages which he described as "predominantly in the nature of restitution for uninsured, recurring casualty losses which have rendered their exempt homestead property virtually worthless."
The Debtor's lawsuit had been pending almost one year at the time he filed the Motion to Authorize Secured Extension of Credit. He did not disclose the existence of the lawsuit in that Motion.
The Chapter 13 Trustee and the Debtor entered into a Stipulation shortly after the Debtor filed his Response. Pursuant to the Stipulation, the parties agreed the Debtor's case would be reopened, the Trustee would withdraw her Motion to Revoke Discharge, and the Debtor would file amended Schedules B and C and a Motion to Employ Special Counsel. Although the Debtor filed a Motion to Employ Special Counsel, he did not immediately seek leave to amend his Schedules. Rather, he filed "Debtor's Motion for Approval of Partial Settlement Agreement." Pursuant to the settlement agreement, the Debtor and his spouse would receive $25,000 from two of the defendants (Susan and Joseph Filosi) in the Essex Superior Court action in exchange for a release. In support of his Motion, the Debtor stated:
Special Counsel, Attorney Robert D. Cohan, disclosed in the Fee Agreement attached to the Debtor's Motion that he had received "a suit fee" from the Debtor and his spouse in the sum of $15,000 which was to be deducted from his contingency fee. He also disclosed that Attorney Philip J. Riley was to be paid 15% of the attorneys' fees payable to his firm up to a maximum of $15,000. The Contingent Fee Agreement was dated June 20, 2003. The Court assumes that Attorney Riley represented the Debtor and his spouse when the commenced the Essex Superior Court action.
Subject to this Court's approval, those proceeds of the settlement agreement allocable to the debtor (after accounting for attorney's fees and expenses and the interest of the non-debtor spouse) would be paid over to special counsel to the debtor and utilized for litigation expenses, costs and fees incurred to date and expected to be incurred prior to and during the trial of the Essex County Litigation, which is scheduled for May 18, 2005.
***
The debtor has claimed his interest in his homestead and all proceeds of such litigation as exempt.
The Chapter 13 Trustee filed a Response to the Debtor's Motion for Approval of Partial Settlement, raising no objections to the terms of the settlement agreement. She indicated, however, that any future settlement proceeds should be held in escrow, and she disputed the Debtor's assertion that all proceeds were exempt. The Debtor and the Trustee then filed another Stipulation in which they agreed that the Court could authorize the terms and conditions of the Settlement Agreement. Additionally, they agreed as follows:
The Chapter 13 Trustee assents to the Debtor's Motion, previously filed, to authorize the employment of Attorney Robert Cohan of Cohan Rasnick Myerson, LLP, One State Street, Boston, MA 02109 as special counsel to the debtor in the Essex Action on the terms set forth in the Contingent Fee Agreement executed by the Debtor, Non-Debtor spouse and counsel.
Attorney Cohan shall hold the proceeds of such partial settlement in escrow and may disburse said proceeds for litigation costs and expenses, including reimbursement for costs advanced and costs to be incurred prior to or during a trial on the merits in the Essex action. Attorney Cohan shall continue to maintain the balance of funds not so expended in escrow pending further order of this Court.
The Debtor and the Trustee also agreed that the Debtor would file amended schedules reflecting receipt of any proceeds from the Essex Superior Court action within 30 days of its conclusion.
On May 12, 2005, the Court approved the employment of Robert Cohan, Esq., as Special Counsel, as well as the Stipulation between the Chapter 13 Trustee and the Debtor. Over a year and a half later, the Debtor filed a Motion to Amend Schedules B and C, as well as amended Schedules B and C. On Amended Schedule B, he described the proceeds from the settlements as follows:
Description Value Debtor's interest in the net proceeds of certain state court $20,241.94* Litigation (Essex Superior Court C.A. No.: 011104) by which Debtor and his nondebtor spouse (CoPlaintiffs) recovered restitution damages for extensive flooding damage to debtor's homestead property, household goods and furnishings, tools of the trade, and other personalty located therein. Debtor asserts that the balance of net proceeds are not property of his estate but are the separate property of his nondebtor spouse. The Debtor also set forth his calculation of his interest in the proceeds. From the total recovery from all parties of $122,500, he added deposits for costs from Hayes Engineering in the sum of $2,535.03; and he subtracted legal fees payable to special counsel in the sum of $40,833.00; costs of suit, which he stated he and his spouse advanced, in the sum of $22,191.28; costs of suit paid from pre-trial settlement with two defendants (Susan and Joseph) in the sum of $21,526.87, leaving net proceeds in the sum of $40,483.88, which the debtor divided by two to determine his one-half interest, namely $20,241.94. The Debtor, by way of an asterisk, noted: "These figures [$20,241.94] do not reflect any claim for payment of administrative or priority claims to be asserted by the debtor and/or the debtor's spouse for sums expended and loans incurred to preserve assets of the debtor's estate during the pendency of these proceedings, or for debtor's attorney's fees to the extent allowed by the Court in connection with this proceeding."On amended Schedule C, the Debtor claimed his share of the settlement proceeds, namely "$20,241.94 or 100% of proceeds" as exempt pursuant to Mass. Gen. Laws ch. 188, § 1 (the Massachusetts homestead statute) and Mass. Gen. Laws ch. 234 [sic]. The Debtor also filed, together with his spouse, "Motion of William H. Thurston and Kathleen Thurston to Allow Administrative Claim pursuant to 11 U.S.C. § 503(b)," as well as a "Debtor's Motion to Authorize Partial Release of Proceeds of State Court Litigation," pursuant to which he sought authority for Attorney Robert Cohan, "to disburse all funds presently held in escrow in excess of $20,241.94, which amount shall continue to be held in escrow pending further determination by the Court."
Presumably, the Debtor meant to reference Mass. Gen. Laws ch. 235, § 34, which lists property exempt from seizure on execution.
Although the Debtor withdrew this Motion, it contains information about the Essex Superior Court action. The Debtor represented that he and his spouse sued abutters, the Town of Middleton, and the builders and engineers of a subdivision allegedly responsible for flooding and damage to their home. The Debtor represented that he and his spouse had expended $16,903 for actual property damage/repairs paid from April 22, 2000 to the present, and incurred indirect legal costs of $1,233.56, direct legal costs of $15,486.72, and expert fees and costs of $5,471. He added that in addition to the foregoing expenses, he and his spouse remain liable for future repairs to their septic system for which they had earmarked proceeds of the litigation in the estimated amount of $211,441. The Trustee objected to the Motion asserting that the Debtor cannot claim that the actions he took were to "preserve property of the estate" because he did not intend to disclose the lawsuit or the proceeds until he was forced to do so.
Within a week of the Debtor's filing amended Schedules B and C, the Trustee filed an Objection to Debtor's Claim of Exemption and a Limited Objection to the Motion to Allow Administrative Claim, in which she asserted that the net recovery of $76,780 held by Attorney Cohan should be divided between the Debtor and his spouse. The Debtor, in response to the Trustee's Limited Objection, contended that the Trustee "assented to the payment of the Thurston's [sic] legal fees and expenses" and that "[a]ny requirement that funds reasonably expended by the Thurstons in obtaining the proceeds then be included [sic] in calculating the amount of those proceeds to be paid over to the Trustee would unfairly penalize the debtor by requiring the turnover of phantom assets already expended in the litigation." The Debtor also raised the issue of the Small Business Administration ("SBA") loan, stating that the proceeds should be paid directly to the SBA in accordance with the Loan Authorization and Agreement, which was attached to his Motion to Authorize Secured Extension of Credit (Home Disaster Loan).
Based upon the figures contained in the Debtor's amended Schedules, the Court is unable to determine how Attorney Cohan came to be holding $76,780.
In his response to the Trustee's Objection to his claimed exemption, the Debtor stated that, as of the date of the filing, two flooding incidents had occurred, one in 1996 and the other in 1998, but that the majority of the flooding incidents occurred after the filing and resulted in the Essex Superior Court action in 2001. Indeed, representations made by the Debtor in the Loan Authorization and Agreement provided that the damage occurred in March 2001.
On February 23, 2007, the Debtor, his spouse, and the Chapter 13 Trustee executed yet another Stipulation with respect to Debtor's Motion for Partial Release of Proceeds of State Court Litigation which provided that Special Counsel Robert Cohan was authorized to release the sum of $45,890 to Kathleen Thurston, leaving a balance of $30,890. According to the parties, that sum of $45,890 represented the return of the retainer previously paid to Attorney Cohan by Kathleen Thurston together with her 50% share of litigation proceeds currently held in escrow. The parties further agreed that the balance of the proceeds would continue to be held in escrow by Attorney Cohan. On February 23, 2007, the Court approved the Stipulation. As a result of the Stipulation, Special Counsel holds the sum of $30,890 in litigation proceeds in escrow.
On April 17, 2007, after withdrawing the Motion to Allow Administrative Claim Pursuant to 11 U.S.C. § 503(b), the Debtor filed a Motion to Authorize (1) Reimbursement of out of Pocket Costs Incurred by Debtor in State Court Litigation and (2) Payoff of SBA Disaster Loan from Settlement Proceeds, to which the Trustee objected, observing that the Debtor's spouse was responsible for repayment of the SBA loan according to its terms. Pursuant to his Motion, the Debtor sought authority to pay $11,095 in "actual and necessary litigation expenses, including court costs, deposition costs, and expert fees," and the balance due on the SBA loan in the amount of $11,500.
III. POSITIONS OF THE PARTIES
The Trustee, in her Objection to the Debtor's Claim of Exemption, asserted that the Debtor was not entitled to deduct any fees or costs from the total settlement proceeds and that his 50% share of the settlement should have been listed on Schedule B in the amount of $42,101 ($122,500, plus $2,535.03 from Hayes Engineering, minus $40,833 in Special Counsel's legal fees divided by two). She also asserted that the Debtor was not entitled to claim a homestead exemption in litigation settlement proceeds, "regardless of whether they relate to exempt real estate or not, as they are not insurance proceeds, but are the result of a lawsuit filed by the Debtor and his spouse." She noted that the Debtor could conceivably use the proceeds for whatever purposes he deemed necessary and cannot claim a homestead merely because he intends to use the proceeds to repair his property. She further noted that the Debtor failed to disclose the prepetition damage claim on Schedule B, as well as the lawsuit which he commenced postpetition in the state court, adding that he has acted in bad faith. Finally, she observed that because the Massachusetts homestead was limited to $100,000 on March 8, 1999, when the Debtor filed his Chapter 13 petition, and he has already claimed $96,096 as exempt, the maximum amount of the settlement proceeds which he could claim as exempt would be $3,904.
The Debtor, in his response to the Trustee's Objection to his homestead, stated that the settlement proceeds are akin to the proceeds of an involuntary sale or conversion of a portion of his homestead and the proceeds compensate him for the value of the property. In his Motion to Authorize (1) Reimbursement of out of Pocket Costs Incurred by Debtor in State Court Litigation and (2) Payoff of SBA Disaster Loan from Settlement Proceeds, to which the Trustee objected, the Debtor asserted that the settlement proceeds are not property of the bankruptcy estate and are exempt. He also asserted that if the Court were to determine that the proceeds are property of the estate or are not exempt, he should nevertheless be reimbursed for his expenses in the sum of $11,095 (50% of $22,191.28), and the Court should authorize the payment of the SBA loan from the proceeds prior to distribution to unsecured creditors, noting that the loan balance is $11,500. The Trustee, on the other hand, contended that the Debtor's spouse received more than the amount of costs awarded by the state court, adding that because the Debtor's spouse is a co-borrower with respect to the SBA loan, it was her duty to immediately notify the SBA and turnover $11,500 to it when she received $45,890 as her share of the litigation proceeds.
IV. DISCUSSION
A. The Chapter 13 Trustee's Objection to the Debtor's Claim of Exemption
The first issue confronting the Court is whether, as the Debtor contends, the settlement proceeds are exempt. The Court rejects the Debtor's contention that all the settlement proceeds are exempt simply because they relate to the diminution in value of his homestead as a result of the flooding which precipitated the Essex Superior Court action.
Upon the commencement of a Chapter 13 case, with certain exceptions not pertinent here, the debtor's property becomes property of the estate until it is determined to be exempt. See 11 U.S.C. §§ 541(a), 1306(a). The debtor is required to file a list of property which he claims as exempt, and "[u]nless a party in interest objects, the property claimed as exempt on such list is exempt." See 11 U.S.C. § 522(1). See also Taylor v. Freeland Kronz, 503 U.S. 638, 642 (1992). Property that is exempted is not liable during or after the case for any debt of the debtor that arose before the commencement of the case. See 111 U.S.C. § 522(c). The validity of the claimed exemption is determined as of the date of the filing of the petition. 11 U.S.C. § 522(b)(2)(A) (1994). In re Cunningham, 354 B.R. 547, 553 (D. Mass. 2006) ("It is hornbook bankruptcy law that a debtor's exemptions are determined as of the time of the filing of his petition.").
Federal Rule of Bankruptcy Procedure 4003 governs objections to claimed exemptions. Subsection (b) provides, in pertinent part, that a party in interest may object to the list of property claimed as exempt within 30 days after any amendment to the list or supplemental schedules, and subsection (c) provides that the objecting party has the burden of proving that the exemption is not properly claimed.
Initially, the objector to a claim of exemption bears both the burden of production and the burden of persuasion. The objector must produce evidence sufficient to rebut the "presumptively valid exemption." The evidence produced by the objector may shift the burden of production to the debtor to produce "unequivocal evidence that the exemption is proper," but the burden of persuasion always remains with the objector. The objector must overcome the "prima facie effect of the claim of exemption" by a preponderance of the evidence. If the objector does not prove by a preponderance of the evidence that the exemption should be disallowed, then the claimed exemption will stand.
In re Holt, 357 B.R. 917, 921 (Bankr. M.D. Ga. 2006) (citing, inter alia, In re Carter, 182 F.3d 1027, 1029 n. 3 (9th Cir. 1999)).
As noted by the Court in In re Kaelin, 308 F.3d 885 (8th Cir. 2002), although the general rule is liberal allowance of exemption claims, there are two recognized exceptions: "Bad faith on the part of the debtor and prejudice to creditors." Id. (citing In re Doan, 672 F.2d 831, 833 (11th Cir. 1982) ("[A] court might deny leave to amend on a showing of a debtor's bad faith or of prejudice to creditors.")); In re Osborn, 24 F.3d 1199, 1206 (10th Cir. 1994) (same); Lucius v. McLemore, 741 F.2d 125, 127 (6th Cir. 1984) (noting that courts may deny an amendment where the debtor has acted in bad faith or where property has been concealed).
Pursuant to section 522(b), the Debtor, as a Massachusetts resident, was entitled to elect between state and federal exemptions. In re Garran, 338 F.3d 1, 4 (1st Cir. 2003). Having elected the state exemptions, he was entitled to claim a homestead in accordance with Mass. Gen. Laws ch. 188, § 1 in the sum of $100,000. See 11 U.S.C. § 522(b)(1), (2). On Schedule C, he claimed a homestead to the extent of $96,096. He neither listed his contingent unliquidated claims against his neighbors and the Town of Middleton on Schedule B nor claimed them as exempt on Schedule C.
Because the Debtor filed his petition in 1999, his case is governed by the bankruptcy statute in effect at that time and is unaffected by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. Moreover, his homestead exemption is limited by the cap in place in 1999.
The Massachusetts homestead statute in effect at the time the Debtor filed his bankruptcy petition provided in relevant part the following:
An estate of homestead to the extent of $100,000 in the land and buildings may be acquired pursuant to this chapter by an owner or owners of a home or one or all who rightfully possess the premise by lease or otherwise and who occupy or intend to occupy said home as a principal residence.
Mass. Gen. Laws ch. 188, § 1 (version applicable to the Debtor's case in 1999, prior to the 2000 amendment). Because the Chapter 13 Trustee did not object to the Debtor's original claim of homestead, the Debtor successfully exempted an estate of homestead to the extent of $96,096. The Debtor now seeks to exempt additional funds on the theory that "the proceeds, rights of action and incidents of ownership" attributable to his exempt homestead have also been withdrawn from property of the estate. He posits that the uninsured property damage claim "stands for" or "represents" the property itself and "has no existence apart from the property to which it relates as the measure of damages is the extent to which the property itself has been damaged."
While the Debtor's argument may have superficial appeal, it misses the mark. The Debtor is not entitled to an estate of homestead greater than $100,000 or an estate of homestead in cash settlement proceeds for the very simple reason that such proceeds cannot be occupied. The Debtor is improperly attempting to transform an unliquidated prepetition claim, which should have been listed on Schedule B-Personal Property, into an exempt prepetition asset related to his homestead, although when the claims, some of which may have arisen postpetition, were liquidated, the proceeds became property of the Debtor's estate pursuant to 11 U.S.C. § 1306. The Debtor has not pointed to any provision in the Bankruptcy Code for exempting property that becomes property of the estate under section 1306, and there is no provision under the Massachusetts homestead statute for exempting cash proceeds.
Notably, section 522(b) references section 541 ("Notwithstanding section 541 of this title, an individual debtor may exempt from property of the estate . . ."); it does not reference section 1306. Moreover, the Massachusetts homestead statute, as the Trustee correctly recognized, has no provision for the exemption of settlement proceeds relating to the diminution in value of the Debtor's property, and there is no evidence of the value of the Debtor's homestead other than the $145,000 value he utilized on Schedule A-Real Property filed on April 6, 1999, at which time the secured debt encumbering the property was $59,508, and the $150,000 value he set forth in his Motion to Authorize Secured Extension of Credit filed on May 15, 2002 after the flooding which took place in March of 2002, at which time the secured debt encumbering the property was $48,700. At the time of the filing the Debtor and his spouse had equity in their property in the sum of $85,492, and at the time they borrowed money from the SBA, their equity had increased to $101,300, although as a result of the SBA loan, the equity was reduced by $6,692. It is unclear to this Court how the settlement proceeds could be a substitute for the homestead exemption because the Debtor's equity increased up until the time he borrowed money from the SBA. Although the Debtor and his spouse may have additional expenses related to the property, the existing evidence does not support the assertion that the property diminished in value and that the settlement proceeds are exempt.
Because the Debtor and his spouse have paid $11,000 toward the SBA loan ($22,500 minus the balance due of $11,500), even assuming that the value of the property has remained unchanged since 2002, their equity now exceeds $100,000.
In addition to the Court's determinations set forth above, the decision in In re Plant, 300 B.R. 22 (Bankr. D. Ariz. 2003), is instructive, and this Court's decision in In re Hyde, 334 B.R. 506 (Bankr. D. Mass. 2005), which involved a Chapter 7 debtor's post-discharge, voluntary private sale of his residence, for which he had claimed a homestead and which was abandoned by the Trustee, is distinguishable.
In Plant, the debtor filed a Chapter 7 petition and, in her schedules, disclosed a cause of action against a corporation which failed to perform or negligently performed work on her home. While she listed the cause of action as an asset, she did not claim it as exempt on Schedule C. Additionally, the debtor represented that the corporation had filed its own bankruptcy petition and that it was unlikely that she would receive a dividend on her claim in its case. The Chapter 7 trustee did not administer the asset, and the debtor's case was closed after she received a discharge. The debtor subsequently obtained a sizable settlement from the corporation, a circumstance which caused the trustee to file a motion to reopen, coupled with a request to have the entire settlement amount turned over to the bankruptcy estate as non-exempt property. The debtor objected, arguing that the settlement proceeds should be deemed exempt because they were related to negligent work performed on her home which affected her homestead exemption.
Although the Arizona exemption statute contained language exempting "[a]ll money arising from any claim for the destruction of, or damage to, exempt property and all proceeds or benefits of any kind arising from fire or other insurance upon any property exempt under this article" as well as "[a]ll money arising from fire or other insurance upon any property exempt from sale on execution under this article," relating to personal property, it contained no comparable language with respect to homestead property. 300 B.R. at 23-24. The bankruptcy court determined that the legislature's omission was intentional and "the plain and unambiguous language used in the statute prevents such a construction." Id, at 24. The court also observed that the settlement had never been allocated so that it was impossible to determine what proceeds, if any, actually related to the diminution of the value of the home. Id. at 25. It concluded that the proceeds arising from a settlement relating to homestead property were not exempt.
The decision in In re Gilley, 236 B.R. 441 (Bankr. M.D. Fla. 1999), would appear to favor the Debtor's position. Upon close examination, however, it is distinguishable. In Gilley, the debtor claimed a homestead under Florida law, which provides:
(a) There shall be exempt from forced sale under process of any court, and no judgment, decree or execution shall be a lien thereon, except for the payment of taxes and assessments thereon, obligations contracted for the purchase, improvement or repair thereof, or obligations contracted for the house, field or other labor performed on the realty, the following property owned by a natural person:
(1) a homestead, if located outside a municipality, to the extent of one hundred sixty acres of contiguous land and improvements thereon, which shall not be reduced without the owner's consent by reason of subsequent inclusion in a municipality; or if located within a municipal ity, to the extent of one-half acre of contiguous land, upon which the exemption shall be limited to the residence of the owner or his family;
(2) personal property to the value of one thousand dollars.
Article X, Section 4 of the Constitution of the State of Florida. In addition, the debtor claimed an interest in certain settlement proceeds as exempt. The debtor, a farmer who previously grew fruits and vegetables on the property surrounding his home, sued E.I. DuPont Company for spraying a chemical fungicide on his properly, contaminating it and rendering it unsuitable for agricultural use. The debtor, who obtained over $1 million in settlement proceeds, indicated that he believed that the entire settlement amount was compensation for damages to his property and that he intended to use the settlement proceeds to rehabilitate and restore the property. He claimed the settlement proceeds as exempt "because they represent compensation for the loss of value of his homestead real property, and that the proceeds therefore maintain the same exempt character as the underlying homestead property," analogizing the proceeds to a fire insurance contract, which qualify for exempt status under Florida law provided that the insured property itself qualifies for exemption. 236 B.R. at 444.
The court in Gilley, framed the issue as follows:
[W]hether a debtor may properly claim as exempt, pursuant to Florida's homestead exemption law, the cash proceeds of a cause of action based on damage to the debtor's homestead real property, when the proceeds are segregated, and when the Debtor intends to reinvest the proceeds into the homestead real property to rehabilitate the property.
Id. at 444-45. The court observed that the Florida homestead exemption, like the Massachusetts homestead exemption, is liberally construed in favor of the debtor, and that the Florida Supreme Court has concluded that the proceeds of the involuntary conversion of homestead real property are exempt, as well as insurance proceeds payable because of damage to the homestead.Id. at 445. The court also stated that the Florida Supreme Court had ruled that the proceeds of a voluntary sale of homestead real property are exempt so long as the proceeds are segregated and the debtor intends to reinvest the proceeds in a new homestead within a reasonable period of time. Id, (citing Orange Brevard Plumbing Heating Co. v. La Croix, 137 So.2d 201, 206-07 (Fl. 1962)). In the Orange Brevard Plumbing case, the Florida Supreme Court determined that the principle established by its decision was akin to the doctrine of equitable conversion: "[t]he funds resulting from the voluntary sale of the homestead are 'converted', and while 'in transit' assume the character of the exempt real property. . . ." 137 So.2d at 207.
Based upon precedent from the Florida Supreme Court, the bankruptcy court concluded that the settlement proceeds obtained by the debtor were "the type of proceeds that retain the homestead character of the underlying real property," a portion of which was used for agricultural purposes. 236 B.R. at 445. It stated:
The settlement funds represent compensation to the Debtor for the diminution in the value of his homestead real property for those agricultural purposes. The settlement funds do not appear to represent the proceeds of a claim for any personal suffering or damages unrelated to the value of the property. The Court concludes that since the funds represent compensation for the loss in value of the property resulting from the use of the chemical fungicide, they essentially are a substitute for the homestead real property.
Id. at 446.
The Gilley case is distinguishable from the instant case because the Florida homestead exemption which is contained in its constitution, unlike the Massachusetts homestead exemption statute, is not subject to a dollar limitation. Moreover, Massachusetts courts recognize the principle set forth in In re Reed, 184 B.R. 733 (Bankr. W.D. Tex. 1995), and "hold that a postpetition change in the character of property properly claimed as exempt will not change the status of that property, relying on the principle that once property is exempt, it is exempt forever and nothing occurring postpetition can change that fact." Id. at 737 See In re Cunningham, 354 B.R. at 554, 556-57 (quoting Reed, 184 B.R. at 737). See also In re Hyde, 334 B.R. 506, 515 (Bankr. D. Mass. 2005). The court in Cunningham explained: "the reasoning of Reed indicates that once property is exempted under § 522 of the Bankruptcy Code, it is forever removed from the bankruptcy estate and permanently immunized from pre-petition debts, although it has no effect on whether the property qualifies as 'exempt' under state law." 354 B.R. at 556-57.
In the Debtor's case, his homestead, to the extent of $100,000, was removed from the bankruptcy estate. The settlement proceeds did not exist at the time he filed his Chapter 13 case, only his contingent, unliquidated claims against abutters to his homestead property existed. When he received the settlement proceeds, they became property of his bankruptcy estate pursuant to 11 U.S.C. § 1306. The Debtor cannot simply transform those cash proceeds into exempt property by asserting that they relate to his $100,000 exemption. Massachusetts law simply does not so provide. Indeed, In re Wiesner, 267 B.R. 32, 36 (Bankr. D. Mass. 2001), the court rejected the argument that the debtor's exemption of his premises and its contents, which were destroyed by fire postpetition, removed the insurance proceeds from the bankruptcy estate.
The facts in Wiesner, are analogous to the facts in this case. The debtor filed a voluntary Chapter 7 case. Tragically, less than ten hours after filing his Chapter 7 petition, he died as a result of a fire which destroyed his residence and its contents, which were covered by a homeowner's insurance policy. He claimed his residence, to the extent of $300,000, as exempt pursuant to Mass. Gen. Laws ch. 188, § 1A, as well as household goods and tools. The debtor did not disclose the existence of any insurance policies on Schedule B, and the debtor did not claim an exemption in any policy. 267 B.R. at 35.
Approximately four months after the fire, the Chapter 7 trustee filed a Notice of Abandonment with respect to the estate's possessory and fee interest in the debtor's residence. The trustee, however, specifically reserved his rights to any proceeds from the property, citing 11 U.S.C. § 541(a)(6). Following the filing of the Notice of Abandonment, to which no objections were filed, the debtor's father was appointed administrator of his probate estate. Id.
The trustee negotiated a settlement with the insurer whereby the insurer agreed to pay up to the policy limits for the premises and a substantial sum for the actual cash value of the personal property destroyed in the fire. The administrator objected to the settlement and moved to dismiss the debtor's Chapter 7 case. He argued that "pursuant to the debtor's exemptions or the [t]rustee's abandonment of the [p]remises as well as general principles of equity, all of the insurance proceeds are property of the probate estate, not the bankruptcy estate," adding "that he should be the party negotiating with the [i]nsurer because the [t]rustee, having no real interest in the proceeds, has proposed a settlement that deprives the probate estate of additional insurance proceeds." Id. at 36.
The bankruptcy court determined that the debtor had an interest in the insurance policy as a personal contract under Massachusetts law and that the homeowner's insurance policy was property of the estate under 11 U.S.C. § 541(a)(1). The court stated: "'[F]ire insurance policies are personal contracts providing for the payment of indemnity to the insured in case of loss, and the amount received does not stand for or represent the property damaged or destroyed although the measure of indemnity depends upon the value of the interest of the insured in the property covered by the policies.'" Id. (quoting Converse v. Boston Safe Deposit Trust Co., 315 Mass. 544, 548, 53 N.E.2d 841 (1944)). The court next determined who was entitled to the insurance proceeds: the administrator, standing in the shoes of the debtor, or the trustee, as the bankruptcy estate representative. Id. Relying upon Payne v. Wood, 775 F.2d 202, 204 (7th Cir. 1985), cert. denied, 475 U.S. 1085 (1986), the administrator argued, as the Debtor argues in the instant case, that the exemption of the premises and certain of its contents withdrew that property from the bankruptcy estate, and once withdrawn, any proceeds relating to the property were withdrawn as well. The court stated:
The Payne court . . . ignored the fundamental concept that the insurance policy is an asset separate and distinct from the insured property. Although a majority of states find otherwise, see Lee R. Russ Thomas F. Segalla, Couch on Insurance 3d § 66.53 (1997), under Massachusetts law the policy does not run with or stand in place of the property. Converse, 315 Mass. at 548, 53 N.E.2d 841. See also Hoffpauir, 258 B.R. at 455; In re Simpson, 238 B.R. 776, 779 (Bankr. S.D. Ill. 1999) ("A debtor's right to insurance proceeds for damage to property derives, not from the property itself, but from a contract of indemnification between the debtor and the insurance company. The contract is personal to the debtor and does not 'run with' the property or remain in effect once the property changes hands."); In re Fox, 80 B.R. 753 (Bankr. W.D. Pa. 1987). Consequently the exemption of the Premises and the personal property removed only those items, not the policy insuring them or the proceeds of the policy.
Based upon the decisions in Plant and Wiesner, the Court finds that the Chapter 13 Trustee has satisfied her burden of pointing to evidence in the record sufficient to rebut the Debtor's claimed exemption. The Debtor failed to convince this Court that his claimed exemption in the settlement proceeds relating to his action in the Essex Superior Court was proper. This Court rejects the Debtor's attempt to transform his damage claims into an exempt asset merely because they relate to his residence, $100,000 of which is exempt under Massachusetts law. This Court cannot ignore the nature and existence of the inadequately disclosed asset, which was not the equivalent of an estate of homestead at the commencement of the Debtor's case in 1999, but a separate form of property that had to be exempted in its own right. Although the Court need not determine that the Debtor acted in bad faith, his belated amendments to his Schedules suggest concealment of an asset and prejudice to creditors, who may have questioned the Debtor about his claims against the abutter to his real property had they been adequately disclosed. See Hannigan v. White (In re Hannigan), 409 F.3d 480, 481-82 (1st Cir. 2005) ("a bankruptcy court has discretion to deny the amendment of exemption where the amendment would prejudice creditor or where the debtor has acted in bad faith or concealed assets").
B. The Debtor's Motion to Authorize (1) Reimbursement of Out of Pocket Costs Incurred by Debtor in State Court Litigation and (2) Payoff of SBA Disaster Loan from Settlement Proceeds
In view of the Court's decision that the settlement proceeds are not exempt property of the estate, the Court denies the Debtor's Motion to Authorize Reimbursement. The Debtor did not voluntarily disclose the Essex Superior Court action, and the out-of-pocket expenses he incurred are analogous to an unauthorized postpetition loan. See 11 U.S.C. § 549.
With respect to the payment of the SBA Disaster Loan from the settlement proceeds, the Court finds that the Debtor's spouse, as a co-Borrower under the Loan Authorization and Agreement, was required to "promptly submit" the proceeds of the settlement to the SBA pursuant to ¶ 7B of the Loan Authorization and Agreement. To the extent that she has not done so, the Court finds that she and the Debtor are jointly responsible and equally liable for repayment of the SBA loan. Accordingly, Special Counsel who is holding the sum of $30,890 in escrow is directed to pay one-half of the balance of the SBA loan and remit the balance of the settlement proceeds to the Chapter 13 Trustee.
V. CONCLUSION
In accordance with the foregoing, the Court shall enter an order sustaining the Chapter 13 Trustee's Objection to the Debtor's Claim of Exemption reflected on his Amended Schedule C filed on December 4, 2006, and allowing in part and denying in part the Debtor's Motion to Authorize (1) Reimbursement of Out of Pocket Costs Incurred by Debtor in State Court Litigation and (2) Payoff of SBA Disaster Loan from Settlement Proceeds.